Relevant Cost Analysis—Quality Improvements Destin Company produces water control valves, made of brass, which it sells primarily to builders for use in commercial real estateconstruction. These valves must meet rigid specifications (i.e., the quality tolerance is small).Valves that, upon inspection, get rejected are returned to the Casting Department; that is, theyare returned to stage 1 of the four-stage manufacturing process. Rejected items are melted andthen recast. As such, no new materials in Casting are required to rework these items. However,new materials must be added in the Finishing Department for all reworked valves. As the costaccountant for the company, you have prepared the following cost data regarding the productionof a typical valve:[LO 17-5]Cost Casting Finishing Inspection Packing TotalDirect materials $200 $ 12 $-0- $ 8 $220Direct labor 110 120 20 20 270Variable manufacturing overhead 100 150 20 20 290Allocated fixed overhead 70 80 40 10 200$480 $362 $80 $58 $980The company, spurred by intense price pressures from foreign manufacturers, recently initiateda number of quality programs. As a result, the rejection rate for valves has decreased from 5.0% to3.5% of annual output (equal in total to 15,000 units). The reduction in reject rates has enabled thecompany to reduce its inventory holdings from $400,000 to $250,000. Destin estimates that theannual financing cost associated with inventory holdings is 12%.Required1. What are the estimated manufacturing cost savings per year (to the nearest whole dollar) associated withthe reduction in rework costs?2. What is the annual financing cost savings (to the nearest whole dollar) associated with the reduction ininventory holdings?3. Provide a dollar estimate of the total annual cost savings (to nearest whole dollar) associated with therecently enacted quality improvements.
Relevant Cost Analysis—Quality Improvements Destin Company produces water control valves, made of brass, which it sells primarily to builders for use in commercial real estate
construction. These valves must meet rigid specifications (i.e., the quality tolerance is small).
Valves that, upon inspection, get rejected are returned to the Casting Department; that is, they
are returned to stage 1 of the four-stage manufacturing process. Rejected items are melted and
then recast. As such, no new materials in Casting are required to rework these items. However,
new materials must be added in the Finishing Department for all reworked valves. As the cost
accountant for the company, you have prepared the following cost data regarding the production
of a typical valve:
[LO 17-5]
Cost Casting Finishing Inspection Packing Total
Direct materials $200 $ 12 $-0- $ 8 $220
Direct labor 110 120 20 20 270
Variable manufacturing
Allocated fixed overhead 70 80 40 10 200
$480 $362 $80 $58 $980
The company, spurred by intense price pressures from foreign manufacturers, recently initiated
a number of quality programs. As a result, the rejection rate for valves has decreased from 5.0% to
3.5% of annual output (equal in total to 15,000 units). The reduction in reject rates has enabled the
company to reduce its inventory holdings from $400,000 to $250,000. Destin estimates that the
annual financing cost associated with inventory holdings is 12%.
Required
1. What are the estimated
the reduction in rework costs?
2. What is the annual financing cost savings (to the nearest whole dollar) associated with the reduction in
inventory holdings?
3. Provide a dollar estimate of the total annual cost savings (to nearest whole dollar) associated with the
recently enacted quality improvements.
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